My preceding post bemoaned the tendency for many US politicians to exhibit a procyclicalist pattern: supporting tax cuts and spending increases when the economy is booming, which should be the time to save money for a rainy day, and then re-discovering the evils of budget deficits only in times of recession, thus supporting fiscal contraction at precisely the wrong time. Procyclicalists exacerbate the magnitude of the swings in the business cycle.
This is not just an American problem. A similar unfortunate cycle — large fiscal deficits when the economy is already expanding anyway, followed by fiscal contraction in response to a recession — has also been visible in the United Kingdom and euroland in recent years. Greece and Portugal are the two most infamous examples. But the larger European countries, as well, failed to take advantage of the expansionary period 2003-07 to strengthen their public finances, and instead ran budget deficits in excess of the limits (3% of GDP) that they were supposed to obey under the Stability and Growth Pact. Then, over the last few years, politicians in both the UK and the continent have made their recessions worse by imposing aggressive fiscal austerity at precisely the wrong time.
Historically, developing countries used to be the ones where dysfunctional political systems produced procyclical fiscal policies. Almost all of them showed a positive correlation between government spending and the business cycle during the period 1960-1999. But things have changed. Remarkably, during the decade 2000-2010, about a third of emerging market governments – in countries such as China, Chile, Malaysia, Korea, Botswana, and Indonesia – managed to reverse the historical correlation. They took advantage of the boom years 2003-2007 to strengthen their budget positions, saving up for a rainy day. They were thus in a good position to ease up when the global recession hit them in 2008-09.
In fact a majority of the governments that have followed countercyclical spending policies since 2000 are in emerging market or developing countries. They figured out how to achieve countercyclicality during the last decade, precisely the decade when so many politicians in “advanced countries” forgot how to.